Does Canada have a housing bubble?

Knowing what happened when real estate bubbles burst in the U.S., Ireland and other countries, it is worth asking whether Canada has a bubble in its urban markets. Bank of Canada governor Mark Carney and others say (hope) the answer is ‘no’, but he keeps interest rates low, encourages spending and warns people not to go into debt.

Here’s what a recent Globe and Mail report said: “The Economist thinks Canadian housing is overvalued by a third relative to income. The Fitch ratings agency pegs the overvaluation at 20 per cent.

“To be sure, Mr. Carney no longer sounds as worried about a housing bubble as he did last year. On Wednesday, he indicated that repeated warnings by him and Finance Minister Jim Flaherty may be scaring Canadians straight, curbing their appetite for debt. But both men are up against history. When property prices get this frothy, pendulum swings are more likely than soft landings.

“Such is the pickle in which Mr. Flaherty and Mr. Carney find themselves. Their risky experiment in guiding Canada through the recession by stoking housing demand is threatening to come undone. Household debt (largely the result of ever-bigger mortgages) remains much higher in Canada than it was in the U.S. just before the 2008 crash. It wouldn’t take much to turn a vulnerability into a calamity.”

When a bubble bursts, according to House Price Index, wealth decreases with the fall in expenditure on real estate and other products, and leads to a general recession.

Household debt (largely the result of ever-bigger mortgages) remains much higher in Canada than it was in the U.S. just before the 2008 crash. It wouldn’t take much to turn a vulnerability into a calamity.

What are the facts about housing prices in Canada? The index for Canadian cities shows that, from mid 2005 to the present, real estate prices have risen:

Toronto — 46 per cent or 6.6 per cent per annum

Ottawa — 41 per cent or 5.9 per cent per annum

Calgary — 61 per cent or 8.7 per cent per annum

Vancouver — 62 per cent or 8.9 per cent per annum

If that were the annual rate of inflation for all goods and services since 2005, it would be cause for concern. Should it be for housing?

When times get tough, foreigners put their money in gold, Swiss bank accounts and real estate in a number of countries. This is especially the case for buyers from developing countries and places where there is less security. North America — and in the past, Europe — have acted as depositories for such foreign funds.

Is this what’s happening here now? Are Chinese and other foreign investors inflating the Canadian real estate market? There is plenty of wealth in the Middle East, India and other parts of Southeast Asia besides China. Australia appears to think that there needs to be some control on foreigners buying real estate if they don’t intend to live there. So far, Canada has made no such moves. Should we?

China’s ‘Potemkin’ cities — ghost towns built for several million inhabitants but remaining largely empty — provide a lesson in the vagaries of real estate investment which might have some relevance for Canada. These cities, which the Chinese government finances in order to maintain investment spending, are to westerners the result of unusual policies. Chinese, however, appear willing to invest in ghost cities without much (if any) hope of renting, selling or living in their properties. If they buy under these conditions, why would they not invest in Canadian real estate also?

According to their own government they are not allowed to — but this appears to do little to prevent investors from circumventing the rules. Add to that the wealth of investors in India, the Middle East and other parts of Asia and the real estate buying pressure from foreigners is added to that of already free-spending Canadians.

My strong impression is that we do have the makings of a real estate bubble, and the cocktail circuit in Canada confirms it. There, people are boasting about buying condos as investments even though rental rates don’t cover the costs right now, and those investments will be even harder to justify when interest rates rise and prices fall. Foreign buying adds to this upward pressure on prices.

Christopher Maule retired in 1996 from full-time teaching in economics and international affairs at Carleton University. He is a regular contributor on topics ranging from the cultural industries, to productivity and immigration.

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